Minimum capital enforcement on finance companies to increase depositors’ confidence
View(s):All licensed finance companies would now have to maintain a minimum level of capital in their balance sheets to account for any losses in their lending books after the new capital regulations that will take the form of BASEL rules on banks.
This has come on the back of the International Monetary Fund (IMF) revealing in a recent report that of the 46 licensed financial companies in Sri Lanka, 15 are presently facing liquidity issues, with six at a high level of distress with Non Performing Loans ranging from 50 to 90 per cent.
By July, the tier I and tier II ratios of licensed finance companies will increase to 8.5 per cent and 12.5 per cent from the current 5 per cent and 10 per cent.
This measure will reduce the sector’s vulnerabilities, and will increase the confidence of the deposit-holders, analysts say. “The ability of financial institutions to attract and retain depositors would depend on their capabilities to maintain the public confidence and trust, in fulfilling the essential depository and intermediary functions entrusted to them,” an analyst pointed out noting that the confidence of the depositors in these respects is key. As financial institutions act as fiduciaries in safe keeping and safe handling of public deposits, such measures by the Central Bank (CB) add to the public’s trust in this sector which has eroded in the past, he added.
“New capital-adequacy regulations for Sri Lankan finance companies are likely to improve the resilience of the sector to economic shocks, but will add to capitalisation pressures— particularly for the country’s numerous small-scale finance companies,” Fitch Rating has said in a recent statement.
The new capital requirements will also force the industry to consolidate more, because smaller firms may not be able to maintain such capital standards, another analyst pointed out.
“The larger and well-managed firms are already meeting the new standards. If they are keen, they can buy out some of the smaller firms who are in need of capital, but have good governance,” he noted. This is more effective than some of the previous measures announced 4-5 years ago which basically forced the companies to merge, he said.
However, this also raises the issue of what course of action CB would take in the event an existing finance company is not able to meet the standards, and is not able to merge with a larger firm, the first analyst added. “This is a key piece of the legislation, which isn’t announced as yet. This category poses the biggest risk in the sector,” he said.